What if Bernanke Had the Character to Be Candid?

by William K. Black, New Economic Perspectives

Editor’s note: This was written before Ben Bernanke’s congressional testimony this week.

David Wessel has just published a fantasy piece in the Wall Street Journal that asks the question “what if Bernanke could be blunt” in his Congressional testimony later this week. Here are the first two things that Wessel envisions a blunt Bernanke as telling Congress:

One. [T]he U.S. is doing a heck of a lot better than the rest of the developed world.

Two. You in Congress are hurting the economy now by allowing the sequester to stick and hurting the economy in the future by refusing to deal with long-term deficits. The Fed is trying to offset this, but there’s only so much we can do.

Wessel’s column has prompted me to ask a more important question: what would Bernanke tell Congress if he had the character to be candid. Many witnesses have been blunt with Congress. The problem is that one can be a blunt and dead wrong. It takes character for a Fed Chairman to tell Congress that the economy is screwed up because the Fed screwed up on his watch. That candor is what the Nation needs and the character that produces such candor has been sadly lacking among Fed chairmen.

I have written numerous articles explaining that the Fed had the unique statutory authority under Home Ownership and Equity Protection Act of 1994 (HOEPA) to ban liar’s loans issued by lenders who did not have federal deposit insurance. I have shown that Alan Greenspan and Ben Bernanke received ample warnings of twin epidemics of mortgage fraud consisting of endemically fraudulent “liar’s” loans and appraisal fraud. These frauds were overwhelmingly driven by lenders and the perverse incentives their compensation schemes produced among their agents, particularly loan brokers.

Greenspan refused to use HOEPA to ban liar’s loans and refused to even find the facts about liar’s loans. Bernanke did the same, until he finally give in to intense Congressional pressure and banned liar’s loans in mid-2008. Even then, he delayed the effective date of the rule by 15 months. One would not wish to inconvenience fraudulent lenders.

I explained in prior columns that the appraisers’ formal warnings about mortgage fraud began in 2000 and that the FBI’s famous twin warnings that a mortgage fraud “epidemic” was emerging that would cause a financial “crisis” were made in 2004. I also pointed out that real regulators, operating with far fewer facts and resources, had come to the correct conclusion about “stated income” loans in 1990-1991 and driven them out of the industry. Greenspan and Bernanke both could have acted via regulation to end the fraud epidemic and avoid the Great Recession. Wessel, like Greenspan and Bernanke, conveniently assumes the Fed’s role as a financial regulator out of existence even though Wessel’s focus is on the Great Recession.

It is good to see that Wessel recognizes that the U.S. recovery, while weak on the jobs front, is vastly superior to the Eurozone. The Eurozone as a whole has been forced back into a gratuitous second Great Recession by austerity. The periphery has been forced into a gratuitous second Great Depression, with unemployment rates roughly four times our rates. It is also good to see that Wessel recognizes that the sequester, an austerity program, was an effort to force the disastrous European policies on the U.S. even though everyone could see that the European policies were failing and the U.S.’s stimulus program was producing growth. Yes, it would be good if Bernanke were to tell Congress candidly that austerity in response to a Great Recession is akin to bleeding a patient in response to illness.

There is only one problem with Wessel’s fantasy. He’s writing for the WSJ. So the next line in his fantasy requires Bernanke not to be blunt to Congress but to tell them an internally-inconsistent myth. The myth is that: “You in Congress are hurting the economy now by allowing the sequester to stick and hurting the economy in the future by refusing to deal with long-term deficits.” The first clause is true. The second clause is false and it contradicts the first clause. The U.S. has had (simultaneously) far larger deficits, far greater economic growth and employment, and reasonably stable prices. The claims that the deficit will spiral out of control are based on projections that are so unreliable as to be exercises in fiction. Recall the recent hysteria about the “massive” federal budget deficits and how they supposedly would grow without limit and then strangle the economy. The reality is that modest (relative to the size of our economy and the immense loss of wealth and demand caused by the Great Recession) stimulus plus the automatic stabilizers have produced a moderate recovery of economic growth and a slow recovery of private sector employment. Our states and localities have been running pro-cyclical budgets and employment practices in response to the Great Recession, which has substantially weakened our recovery. Public sector employment has fallen materially, exacerbating unemployment and delaying our recovery from the recession.

Even our moderate recovery, however, has been enough to produce a sharp fall in the federal budget deficit. Indeed, the fall has been far too rapid and is slowing our recovery. A candid Bernanke would explain to Congress that their insistence on debt hysteria is the leading problem slowing the U.S. recovery and that the Fed cannot counteract the harm that Congress and Obama are doing when they inflict austerity.

A candid Bernanke would tell Congress that there was nothing intrinsically “good” or “bad” about a federal budget deficit or surplus for a nation with a sovereign currency that borrows in its own currency and allows its value to float freely. A candid Bernanke would tell Congress that if the U.S. runs a budget “surplus” and our foreign balance were zero then our domestic private sector would have to be in “deficit.” In the modern U.S. context, if you believe that the phrase “federal budget surplus” is a favorable phrase indicative of financial health and moral superiority you must also believe that a “domestic private sector deficit” is a good thing indicative of financial health and moral superiority. The words “deficit” and “surplus” have clear, powerful connotations in everyday life. Deficits are bad and surpluses are good. When we are discussing fiscal policy, however, one sector’s deficit is another’s surplus and context is everything. A candid Bernanke would make this point bluntly to Congress and Wessel and even more bluntly to the European Union’s and IMF’s leaders.